Monday, September 23, 2013

Unintended consequences are fascinating. They are also a good reason why the best intentions, when designed to upend centuries of economic evolution, often end up making the situation worse (see Strategic CSR – Jevons Paradox and, in particular, Strategic CSR – LED lights). The article in the url below extends this phenomenon to a clause of the Dodd-Frank legislation that is designed to curb CEO compensation:

“The irony is that it all came out of such a simple-sounding idea: requiring that the pay of a company’s chief executive be compared to the median salary of its employees. Carrying out the law may well result in costs that are just as obscene as the pay it is disclosing.”

This was a short clause (“only 140 words, in a bill that would eventually run about 2,300 pages”) that was inserted at the last minute with no Congressional debate. As with most hastily generated ideas, what seemed simple in conception is proving to be quite complex to implement in reality:

“What the section required was that all public companies disclose this median number on worker pay, placed side-by-side to the chief executive’s pay. What could be so hard about making such disclosure, right? It turns out plenty.”

The article identifies three main challenges for companies trying to respond genuinely to this provision, the first of which relates to how CEO compensation is actually calculated:

“We are decades past the time when manager compensation was simply what you received in a paycheck. Now, compensation includes options, pensions, 401(k) matches, health benefits, parking allowances and other various prerequisites. Calculating this all as one figure — and in particular valuing average stock options for employees as well as top executives — can be difficult.”

The second problem relates to the fact that this issue of calculating compensation levels has now been extended to all employees:

“Take a multinational conglomerate with 50,000 employees across the globe. That company has the task of not only figuring out the total compensation provided to every employee, but it also has to collect and analyze this information, much of which is in different currencies. And some of this information collection is arguably prohibited by privacy rules in the European Union and other countries like Japan and Canada.”

The third problem relates to timing:

“The number will fluctuate from day to day [e.g., due to exchange rate movements]. The end result is that what was thought a simple calculation is turning into an exercise that could cost some companies millions.”

Not only is this provision of the legislation difficult and expensive to implement, but it is not clear that it will even achieve its intended goals:

“… compensation disclosure has been mandated in some form for decades. But instead of empowering shareholders, it has allowed executives to see what others are paid. This has led to a ‘Lake Wobegon’ effect in executive compensation, pushing each chief executive to demand to be paid ‘above average,’ and the result has been ever-increasing compensation.”

And there is significant anecdotal evidence that, whatever information is provided, is more likely to be misleading than informative:

“If global employees are included, the ratio will be exaggerated by relatively low-paid employees in less-developed countries. The end result is that companies are likely to spend millions for something that is likely to do nothing.”

As with most ill-thought-through, politically-motivated legislation, a solution has been delegated to the bureaucrats who understand the complexities the politicians failed to appreciate:

The article implies that they will be damned if they do and damned if they don’t:

“The hope of companies is that the S.E.C. cuts back on some of the more irrational components of the rule. … The statute, however, is strongly worded, saying the median should be calculated for ‘all employees.’ If the S.E.C. tries to water down the provision as the A.F.L.-C.I.O. suggests, it may lead to a lawsuit in court to strike the rule down by companies themselves.”